Key Takeaways

  • A partnership LLC combines features of partnerships (pass-through taxation) with the liability protection of a corporation.
  • LLCs offer flexibility in management structure, allowing member-managed or manager-managed setups.
  • Partnerships are easy to form but expose owners to unlimited personal liability for debts and actions of co-owners.
  • Both LLCs and partnerships are pass-through entities for federal taxes, though LLCs can elect corporate taxation.
  • Limited Liability Partnerships (LLPs) and Limited Partnerships (LPs) offer hybrid models for specific professional or investment purposes.
  • Deciding between an LLC and a partnership depends on desired liability protection, tax strategy, and control preferences.

What is an LLC Partnership?

This LLC partnership article refers to two types of business entities: a limited liability company (LLC) and a partnership. While they are similar legal forms, they differ by way of personal liability, management controls, formal processes, and other characteristics. 

Partnership vs. LLC – Differences and Similarities

An LLC, which is also known as a limited liability company, is a popular type of business to enact, and it has similar features to another legal structure called a partnership. They are similar in how they are formed and the “pass-through” taxation method but differ by features such as participant liability.

Formation of Partnerships and LLCs

Forming each kind of structure involves similar steps, including registering with the state where the business does the operation. An LLC, however, often requires more documentation to form it than a partnership, as well as following statutory guidelines.

What Is a Partnership?

A partnership is a kind of business with many partners, who are essentially co-owners. To form a partnership:

  • You must have two or more parties who agree to own the business and operate it for-profit.
  • The partners share in management activities equally and share the business’ financial gains and losses.
  • The amount of profit or loss depends on the amount originally invested by the particular owner.
  • Several kinds of partnerships exist, varying according to the industry and owners’ desires.

What Is an LLC?

Forming an LLC involves registering with the state where the business is located, as with a partnership. The majority of limited liability companies operate based on an Operating Agreement, which dictates percentages per member and answers questions as to “what if?” An LLC has the pass-through taxation style of a partnership or sole proprietorship yet has the benefit of personal limited liability like a corporation.

Personal limited liability means:

  • LLC owners have a divide between their personal assets and any judgments against the business.
  • If the business receives a lawsuit or has a debt, only the organization is at risk; the owners’ personal property, such as a vehicle or home, cannot be touched by creditors.
  • Illegal, unethical, or reckless actions by the owners result in the removal of limited liability protection.

Given these distinguishing characteristics, many people consider the LLC format to be an ideal mix of a partnership with a corporation. It is a hybrid structure of partnerships, corporations, and sole proprietorships.

Types of Partnership LLC Structures

A partnership LLC can take multiple forms depending on ownership and liability preferences:

  • Multi-Member LLC (MMLLC): Functions like a partnership but offers limited liability to all members. Profits and losses are shared per the operating agreement.
  • Member-Managed LLC: All members participate in daily management, similar to general partners.
  • Manager-Managed LLC: Members appoint one or more managers to handle operations, providing a structure similar to limited partnerships where passive members have limited roles.
  • Professional LLC (PLLC): Used by licensed professionals (e.g., attorneys, doctors, accountants) to gain liability protection while maintaining personal responsibility for professional conduct.

These structural options allow flexibility while maintaining the core LLC benefit of separating personal and business liabilities

Liability for Partnerships and LLCs

Partners within a partnership have personal liability for the debts incurred in the business and carry personal liability for the activities of the other partners. However, a limited liability company divides the personal assets of the member from any business lawsuit or debt, so that the individual members are not personally held to them. The LLC format provides for personal liability protection for each owner.

There are exceptions to that division between personal and business liability in an LLC though, when:

  • At least one member assurances a business loan
  • The division between business and individuals is vague
  • An owner acts fraudulently or illegally
  • At least one member mishandles business matters
  • Individual members sign for responsibility for specific debts

Personal Liability and Asset Protection

While partnerships expose owners to unlimited personal liability, LLCs protect members’ personal assets. However, this protection has limits:

  • Personal Guarantees: If an LLC member personally guarantees a loan, creditors can pursue that individual.
  • Commingled Funds: Courts may “pierce the corporate veil” if members mix business and personal assets.
  • Fraud or Negligence: Members are personally liable for illegal or reckless actions.
  • Professional Misconduct: In professional LLCs or LLPs, members remain responsible for their own malpractice claims.

Maintaining proper documentation, separate bank accounts, and compliant operations is essential to preserve limited liability status.

Taxes for Partnerships and LLCs

Both structures use “pass-through” taxation, meaning that taxes pass through to the members or partners to declare on their individual tax returns. While a partnership files a partnership tax form annually on Form 1065. Also, a Schedule K-1 is made for each of the partners that show their individual amount of profits or losses over that particular year.

Meanwhile, LLCs are not a tax entity in the eyes of the Internal Revenue Service. Limited liability companies with more than one owner are:

  • Taxed in the same way as partnerships, with the above-mentioned pass-through method for gains and losses tallied on each member’s tax form
  • Differ than single-owner LLCs
    • They are taxed as sole proprietorships
    • Must file a Schedule C in addition to a personal tax return
  • An LLC (single- or multiple-member) can choose to be taxed as a corporation or S corporation instead

Tax Flexibility for Partnership LLCs

A partnership LLC offers several taxation options under the IRS “check-the-box” regulations:

  1. Default Pass-Through Taxation: Multi-member LLCs are taxed like partnerships. The LLC files Form 1065, and members receive a Schedule K-1 for their share of income or loss.
  2. Corporate Election: Members can elect to be taxed as a C Corporation (Form 8832) or S Corporation (Form 2553) to potentially lower self-employment taxes.
  3. Self-Employment Tax Considerations:
    • Partnership income is generally subject to self-employment tax.
    • LLC members in an S Corp structure may reduce taxes by receiving part of income as dividends rather than wages.
  4. State-Level Taxes: Some states impose additional franchise or gross receipts taxes on LLCs not applied to partnerships.

Consulting a tax professional can help determine which structure minimizes tax exposure based on the company’s profits and operations.

Profit and Loss Distribution for Partnerships and LLCs

The disbursement of profits and losses for limited liability companies and partnerships is different than a corporation as there are no shares and no stock is given to members.

Registration and Record-Keeping for Partnerships and LLCs

  • Partnership and LLC reporting guidelines are less specific than corporations
  • There are no requirements to keep records or meeting minutes if a partnership isn’t state registered
  • LLCs must follow some state rules for record-keeping and have meetings, as well as keep separation from members’ personal activities
  • If state-formed, a partnership or LLC must make periodic reports to the state
    • Whether reports are annual or bi-annual depends on the state

Operating Agreement and Custom Allocation

In a partnership LLC, the operating agreement governs how profits, losses, and ownership interests are divided. Unlike traditional partnerships, LLCs aren’t bound by equal distribution rules:

  • Members can agree to allocate profits based on capital contributions, responsibilities, or performance metrics.
  • Losses can be distributed differently from profits to balance capital investment risks.
  • Distributions must comply with the IRS’s “substantial economic effect” test to ensure fairness and avoid audit scrutiny.
  • Clear agreements prevent disputes among members and clarify what happens when members withdraw or are added.

The Limited Liability Partnership: A Special Case

A specific type of partnership is a limited liability partnership, which is also known as an LLP. It involves partners being immune from liability for the actions of their partners. They are still liable for any debts formed within the partnership entity though.

The members of an LLP have the same management guidelines. A major benefit of forming a limited liability partnership is that a partner is not held liable for malpractice claims made against another partner in the same organization.

Limited Partnership (LP) vs. Limited Liability Partnership (LLP)

While both LPs and LLPs provide liability limitations, their structures differ:

  • Limited Partnership (LP): Includes at least one general partner (with full liability) and one limited partner (liability limited to their investment).
  • Limited Liability Partnership (LLP): Protects all partners from personal liability for others’ actions but not for their own misconduct.
  • Ideal Use Cases:
    • LPs often suit investment ventures or real estate projects.
    • LLPs are popular with professional firms (law, accounting, architecture).

In some states like Texas, LLPs must register annually and carry specific insurance coverage to maintain limited liability status.

Limited Liability Company (LLC)

Below are answers to popular questions about the formation and operation of a limited liability company.

Do I Need to Know About Securities Laws to Set Up an LLC?

  • Provided that you are a sole owner and have no plan to accept investments from outside parties, your ownership of the LLC is not seen as a security
    • Thus, you don’t need to know this type of law
  • If you have co-owners, the amount of required knowledge of securities law is less clear
    • The ownership interests are not viewed as securities if all owners play a role in LLC management (as is usually the case)
    • But if there is at least one member who is not an active business manager, such as a friend who invests but does not run any activity in the LLC, then LLC ownership interests are seen as securities by both the state and the federal SEC (Securities and Exchange Commission)

How Many People Do I Need to Form an LLC?

A limited liability company can have just one owner. It only takes one person.

Who Should Form an LLC?

Creating an LLC is favorable if:

  • You want your personal assets to be separate from lawsuits and debts within the organization.
  • You desire personal protection against possible slip-and-fall lawsuits or other possible claims against your company.
  • Common organizations that form limited liability companies are in the banking, insurance, and trust industries.
    • Not every type of business can be an LLC
    • Certain U.S. states do not allow specific professions to create LLCs. For example, California prohibits accountants, doctors, licensed healthcare specialists, and professionals from forming LLCs

How Do I Form an LLC?

For most states:

  • File Articles of Organization in your state
    • Apply to the state LLC filing office, usually within the Secretary of State’s jurisdiction
    • Pay the appropriate filing fee
    • Some states call it a Certificate of Organization or Certificate of Formation
  • It’s a straightforward process; the form is usually a fill-in-the-blank format
  • Get the form by mail or download it online via your state’s main website (search for Secretary of State or corporations section)

Certain states also require:

  • Publish your intention to create a limited liability company in your local newspaper
    • Do so before filing Articles of Organization, not afterward

Also, while it is not a legal requirement in most states, you might decide to write up an Operating Agreement that states the guidelines and rights of the owners of your LLC. This agreement makes it clear what responsibilities each owner is held to and dictates how your company will run. Always follow the LLC laws of the particular state where you are doing business for how to run your organization.

Do I Need a Lawyer to Form an LLC?

The process does not require an attorney as every state enables company owners to create their own LLC simply by providing Articles of Organization. For the Articles of Organization, in almost every state, you must submit:

  • Your LLC name
  • Where the main office is located
  • LLC owner names
  • LLC owner addresses
  • LLC name and address of its registered agent
    • A registered agent is an individual or business that volunteers to accept any legal papers for the LLC

Does My LLC Need an Operating Agreement?

While the majority of U.S. states’ laws on LLCs do not make writing an operating agreement a necessity, you are wise to have one whenever starting a business. The operating agreement is a must-have because:

  • It assists in making sure courts clearly see an owner’s liability protection and supports your LLC as a legitimate company.
  • The agreement sets out how owners will be paid, decision-making processes, and ways to handle owners’ leaving or new owners being added.
  • Assists in avoiding miscommunication between members about management and money.
  • Craft your own operating guidelines rather than being subject to the default LLC laws of the state where you do business as the defaults may not be favorable to you.

How are LLCs Taxed?

A limited liability company is not a separate tax entity from its members. Thus, the LLC pays no taxes itself. It is the LLC owners that instead pay the taxes, with the amount to pay dependent on their allocated amount of profits or subtraction of their piece of the losses; this amount appears on their personal tax forms.

LLC members may decide to be taxed as a corporation. This is often done to reduce tax rates within the business on a significant amount of profits.

What are the Differences Between a Limited Liability Company and a Partnership?

The biggest way they are different is that owners of a limited liability company are not personally liable for business lawsuits or debts. This means:

  • Creditors cannot seek payment from LLC owners for debts.
  • But partners are typically not safeguarded against limited liability
    • The exception is if they are in a limited liability partnership

Another difference is that LLC owners must file Articles of Organization under a formal process, paying the respective fee, and follow other filing guidelines of the state before operating the business. However, starting a partnership does not require any specific papers to be filed or certain dues are paid.

That being said, a major similarity of LLCs and partnerships is taxation. They are almost the same in this regard; owners file personal tax returns to show gains and losses, and the company does not pay tax on these funds.

Can I Convert My Existing Business to an LLC?

The short answer is “yes.” You can turn a sole proprietorship or partnership into an LLC to obtain personal property protection without altering the taxation structure of the company income. To do so:

  • Fill out a straightforward form in certain states to convert the business to an LLC
    • It is typically called a Certificate of Conversion
  • If your state does not offer this form, then you go right to filing Articles of Organization instead
  • Some states require you to publish a notice of intention to end a partnership and turn it into an LLC instead, publishing this announcement in a local newspaper
  • Regardless of the state, you must transfer all licenses, ID numbers, and permits to the new LLC name
    • This includes your state and federal employer ID numbers, sales tax permit, business license (or tax registration number), and professional permits or licenses

Partnerships vs. LLCs

If your new company has more than one owner, you may think about operating as a limited liability company or a partnership. Differences between these legal entities include the formation process.

Formation of General Partnership

  • Form formally or informally
    • There are many methods, such as verbally, written form, and court implied based on party activity (for example, sharing management responsibilities and both losses and profits)
  • The ideal method is a written agreement or Articles of Partnership, but it is not a requirement
    • This paperwork clearly defines partner roles and rights to help avoid court cases later
    • In certain states, the certificate of partnership is mandated for a general partnership to be considered to exist

What is a Limited Partnership?

The majority of partnerships are limited partnerships because passive investors have limited liability with this structure. A limited partnership, or LP for short, has:

  • At least one general partner and at least one limited partner
  • General partners carry out management duties and are completely liable to partnership requirements (100 percent)
  • Limited partners have no authority as managers and are not liable for the partnership rules; they are, therefore, shielded against debts and other requirements of the partnership

Formation of Limited Partnerships

A formal process is used to form an LD. It involves filing a certificate of partnership with the state division, which is typically the Secretary of State’s office. The process is more formal than a general partnership or LLC with co-owners because the owners must agree to an Operating Agreement that sets out the owners’ specific obligations and rights.

If it is an LLC, on the other hand, the owner(s) must file the Articles of Organization, which contains:

  • The LLC name
  • Its principal office location
  • Owner names
  • The foreseen length the LLC will exist
  • Other legal requirements

Management

A general partnership requires that:

  • Each owner manages the business entity
  • Each partner has one vote in decisions regarding the partnership, regardless of how much each partner invests
  • Key business determinations come from majority votes
    • So, partners can nudge co-owners to agree with their ideas for the business
  • One or more partner be the daily operator of the general partnership

For a limited partnership, management by two or more owners is similar to a general partnership except:

  • Limited partners have no management activities in the business
  • Limited partners provide only investment capital

In a single-member LLC, you are responsible for the ownership, management, and operation of the company. It is your decision on how to run the business, strategize, and enact policies, without having to get the approval of anyone else. However, you do not get other viewpoints or experiences as you would with multiple owners.

If there are at least two owners, the Operating Agreement for the limited liability company will dictate the managers’ activities and roles, with the assignment being to the benefit of the company’s needs. You can either have all owners manage the LLC or specific owners do so in defined ways.

Profit-Sharing

How monetary gains and losses are divided is almost the same for general partnerships and multi-owner LLCs.

  • Both LLCs and general partners get equal shares of profits in their companies unless they have agreed to a different structure
  • For limited partnerships, limited and general partners share profits and losses
    • The amount given is dependent on the amount or percentage a partner invested in the organization
  • LLCs, general partners, and limited partners can decide to divvy up profits and losses differently if they want within their business structure, entering into agreements that define these allotments

Legal Liability

General partners in general and limited partnership models have full personal liability as they are the managers of their companies. The differences though are:

  •  Liability for their actions and the other partners fall upon general partners
    • This is called joint liability or several liabilities
  • Risks for limited partners are only the amount of capital they invested
    • This is the same for LLCs and corporation shareholders
  • Should a limited partner participate in business management activities, they are personally liable for those guidelines
  • Limited liability company owners are not usually personally liable for LLC debts or legal cases against the LLC
    • Only their investments to the LLC are in jeopardy
    • But members can still be liable personally for their own actions if they hurt others, breach their duties, or guarantee loans personally

Obtaining the proper insurance and other policies is important for protecting an owner from liability to help keep his or her personal property and company resources safe.

Advantages of an LLC Compared to a Sole Proprietorship and a Partnership

  • No personal responsibility on LLC owners for business debts
  • Creditors can go after owners in partnerships or sole proprietorships to collect funds, whether it be from bank accounts or personal assets, such as cars or homes
    • LLC owners are not generally liable for company debts; they are immune from creditors in this instance
  • Limited liability companies can get monetary funds easier
    • Ways to do so include adding members by selling membership interests and enacting more classes of membership interests that include voting and profit features
  • Simpler to transfer ownership
    • Just transfer ownership interests by selling to third parties without affecting company operations
    • Partnerships and sole proprietorships cannot be fully sold

Additional Benefits of an LLC Partnership

Beyond limited liability, LLCs provide:

  • Flexible Ownership: No restriction on the number or type of members. Entities, individuals, or foreign owners can all be members.
  • Ease of Raising Capital: LLCs can issue different membership classes, accommodating passive investors.
  • Perpetual Existence: LLCs can continue beyond a member’s departure, unlike partnerships which may dissolve automatically.
  • Simplified Compliance: LLCs avoid the strict formalities of corporations but still offer structural protection.

These advantages make LLCs a preferred structure for small business owners seeking both flexibility and asset protection.

Disadvantages of an LLC Compared to a Sole Proprietorship and a Partnership

  • Creation fees
    • Beginning an LLC is more expensive than a partnership or sole proprietorship
  • More paperwork
    • There are no organizing guidelines for a sole proprietorship or partnership; not even a written agreement is necessary. An LLC, however, requires more organization to set it up
  • Division of records
    • Creating the separation of liability protection from the LLC for each member involves keeping precise records so that no confusion over money exist between the business and personal assets

LLC or LP: What’s Best for Your Business?

LLCs and LPs are amongst the most popular types of business entities. Any company can benefit from their structures, including pass-through means of taxation, less rigidity than other entities, limited liability, and defense against creditors. Under tax law, limited liability companies and limited partnerships are seen as general partnerships; however, they also have the limited liability benefits of corporations.

Deciding which one is optimal for your business involves considering:

  • Tax repercussions
  • Type of business
  • Management control
  • Other attributes specific to your type of company

Choosing Between Partnership LLC, LP, or LLP

When deciding among these structures, consider:

  • Liability: LLCs protect all members; LPs only protect limited partners.
  • Management: LLCs offer flexible management options, while LPs restrict control for limited partners.
  • Taxes: Both LLCs and partnerships provide pass-through taxation; LLCs may also elect corporate tax treatment.
  • State Regulations: Some states restrict professional services from forming LLCs, requiring LLPs instead.
  • Exit Strategy: LLCs simplify ownership transfer compared to LPs or traditional partnerships.

Entrepreneurs should evaluate business goals, risk tolerance, and tax preferences when choosing between these entities. For personalized legal guidance, you can find an experienced business attorney through UpCounsel to help structure or convert your company effectively.

Frequently Asked Questions

1. Can an LLC have partners like a partnership? Technically, LLCs have “members” rather than “partners,” but multi-member LLCs function similarly to partnerships, sharing profits, losses, and management responsibilities.

2. Do LLC members pay self-employment tax? Yes, unless the LLC elects corporate taxation. Members’ distributive shares of income are typically subject to self-employment tax.

3. Is a partnership or an LLC better for small businesses? An LLC is generally better for liability protection and management flexibility, while a partnership is simpler and cheaper to form.

4. Can a partnership be converted into an LLC? Yes. Most states allow conversions by filing a Certificate of Conversion or new Articles of Organization. Existing licenses and EINs must be updated.

5. What’s the difference between an LLP and a partnership LLC? An LLP protects partners from others’ negligence, while an LLC shields all members from company debts and lawsuits.

Determining whether to create an LLC or a partnership can seem overwhelming. Reach out to the UpCounsel marketplace to get additional assistance with this venture when you post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.